Markets Make Fools of Us All

As the Dow Jones Industrial Average advanced further above 10,000 yesterday, gold slipped back below $1,200 an ounce. We are not exactly sure what we think about the stock market’s resurgence – or about gold’s retreat – but we are pretty sure what we do NOT think.

We do not think stocks have vaulted into a new bullish trend; nor do we think gold has slumped into a new bearish trend. Rather, the recent moves feel like short-term, counter-trend noise. This noise might last a few weeks, but we would not mistake it for music.

That said, the financial markets could not care less what we say. The financial markets do not even care what Alan Greenspan or Abby Joseph Cohen say. In fact, the financial markets seem to delight in making fools out of sages. For more than a decade, the markets have made a fool out of the conventional “wisdom” that stocks are for buying and holding. During the last eleven and a half years, for example, the S&P 500 Index has delivered a total return of exactly zero.

The markets have also made a fool out of the conventional wisdom that gold is a barbarous relic – a monetary artifact. During the identical eleven and a half-year period when stocks were busy doing nothing, the gold price quadrupled!

Despite these shockingly contrary investment results, the conventional wisdom remains almost as foolish as ever. Gold is still nothing more than a “trading vehicle,” according to Wall Street’s professional sages, and stocks are still the greatest investment asset ever devised by Man. We would not dare to argue with the sages (they are sages after all), but we would point out that economic systems are as susceptible to entropy as natural systems. In other words, economies sometimes breakdown, either partially or completely.

In the natural realm, the Second Law of Thermodynamics asserts that systems tend toward greater entropy, or disorder. In the economic realm, a similar principal pertains, except that the agents of entropy usually go by the title of “Senator,” “Treasury Secretary” or “Federal Reserve Chairman.”

Here in the American economic system, private enterprises are doing their darnedest to prosper. But at the same time, public institutions are doing their darnedest to roadblock the paths to prosperity. In the name of “stimulating the economy,” the Senators are ramping up taxation and deficit-spending, while the Treasury Secretaries are handing out taxpayer money to their friends on Wall Street, without ever asking for the taxpayers’ permission.

In the midst of the resulting entropy, what’s a Federal Reserve Chairman to do? He didn’t authorize the hundred-billion-dollar bailouts and he didn’t vote for the trillion-dollar budget deficits. Nevertheless, he’s the one who’s supposed to clean up the mess. He’s the one who’s supposed to devise and direct a monetary policy that counteracts the ill effects of our nation’s reckless fiscal policy.

Can’t be done.

America is spending trillions of dollars it does not have. She is promising to spend tens of trillions more over the next few years. She won’t have that money either. But Ben Bernanke has it…and we expect him to spend it. As economic conditions worsen – or fail to improve – and as America’s fiscal condition deteriorates, Helicopter Ben is likely to fly to the rescue with a variety of “policy responses” that will all amount to the same thing: dollar-printing. We don’t blame Ben. What else can he do? He did not create the mess and no mortal can clean it up. But a printing press might help…at least for a while.

We don’t make the rules, dear reader; we just try to remember them. And as we remember that economic systems tend toward randomness, we should also remember not to forgot to buy some gold along the way.

“I am bullish on gold,” declares Rick Rule, a serially successful investor in gold mining companies. “I’m bearish on social promises, and as a consequence, bearish on currencies. I suspect that in the near term gold will do well, because it won’t go down. Then gold will start to do well because people will perceive it as going up, rather than merely holding its own in terms of purchasing power.

“I came of age in investing in the ’70s – a great gold bull market,” Rule continues. “Beginning about 1978, when gold began its hyperbolic rise, it was going up from both ‘greed buyers’ and ‘fear buyers.’ I’m a fear buyer of gold; I buy it as catastrophe insurance. What happened at the beginning of 1978 was that the fear buyers would buy it, creating momentum that caused the greed buyers to step in.

“The uptick then reinforced the fear of the fear buyers, and there was this sort of ‘stereo buying’ in gold that caused a true hysteria – taking the gold price from $400 to the $850 blow-off. It wouldn’t surprise me to see the same set of circumstances take place in the next two or three years.”

It’s hard to say whether fear or greed or “stereo buying” is driving the demand for US Gold Eagles. But whatever the primum movens, demand for all types of gold coinage is soaring.

The US Mint’s authorized dealers ordered 97,000 US Gold Eagles in June. That’s down from May’s stratospheric figure, but still one of the strongest months this year. That’s also an impressive quantity when you consider that June was the first month this year the Mint offered fractional (half-ounce, quarter-ounce, and one-tenth ounce) Eagles.

Sales of Silver Eagles topped three million – the fourth time that’s happened this year. (It happened only once in 2009.) Therefore, based on sales for the first half of the year, total sales for 2010 should set another record…easily.

If precious metals prices continue climbing, as Rick Rule expects, the buyers of bullion coins would have plenty of opportunities to pat themselves on the back.

About Eric Fry:

Eric J. Fry, Agora Financial’s Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling. Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant’s Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant’s International and Apogee Research, institutional research products dedicated to international investment opportunities and short selling.

Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts. His views and investment insights have appeared in numerous publications including Time, Barron’s, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.